Liquidated damages – don’t amend clauses in isolation
In agreements lawyers often include liquidated damages clauses. These clauses provide a defined method of calculating damages to be paid to an injured party if the other party is in breach. Such clauses are a genuine pre-estimate of the loss likely to be suffered as a result of a breach of contract. As such they are reasonable and therefore enforceable.
Parties to agreements which include such clause do need to take care however if they subsequently amend the original agreement. In the recent case of Unaoil Ltd v Leighton Offshore Pte Ltd the beneficiary of the liquidated damages clause, Unaoil, became unstuck. The parties had entered into a memorandum of understanding (MOU) in relation to a construction project in respect of which Leighton had submitted a tender.
The MOU provided that if Leighton’s tender was successful it would appoint Unaoil as its subcontractor and Unaoil would be paid $75 million. If, however, Leighton was successful and failed to appoint Unaoil, Unaoil would be entitled to a liquidated damages payment of $40 million. The parties subsequently amended the MOU to include a lower contract price of $55 million but did not amend the liquidated damages provision. Leighton later won the tender but failed to pay the agreed liquidated damages to Unaoil.
The High Court held that the liquidated damages clause was an unenforceable penalty. $40 million may have been a genuine pre estimate of the loss that would be suffered by Unaoil under the original MOU but as the contract price was subsequently reduced by agreement between the parties this ceased to be the case.
A liquidated damages provision requires careful drafting and detailed consideration of the justification for the clause at the time the clause is drafted and also if there is any later amendment to the agreement. This case is a clear example of the unforeseen problems that can arise when parties to an agreement amend isolated clauses in that agreement without considering the impact of those changes on the whole.
If you require professional advice regarding amending clauses and the effect this has on related documentation then contact the author, Liz Appleyard and her team on 01908 306950.